The reasoning behind mergers andacquisitions (M&A) is that two companies together are more valuable thantwo separate companies. The key principle behind buying a company is to createshareholder value over and above that of the sum of the two companies. Thisrationale is particularly alluring to companies when times are tough.
Strongcompanies will act to buy other companies to create a more competitive,cost-efficient company. The companies will come together hoping to gain agreater market share or achieve greater efficiency. Because of these potential benefits,target companies will often agree to be purchased when they know they cannotsurvive alone (Brigham, 1986; Cybo-Ottone and Murgia, 2000; Brealey and Myers,2003).The advantages stemming fromM&As have been evaluated in terms of the ability to exploit scale and scopeeconomies, gain market control, economize transaction costs, diversify risks,and provide access to existing know-how. Nonetheless, empirical evidence onM&As has also suggested that M&As might fail because of over-optimisticexpectations of benefits and underestimation of postintegration difficultieslike lack of market or technology relatedness, business culture clashes, etc.(Ševi?, 1999).
The two main approaches to tackle this issue empirically arestock price studies and strategic management studies.Most of the empirical literatureon merger outcomes is based on stock price studies. These studies rely onwidely available information on stock prices and apply event study methodology(i.e., to single out the effect of the announcement of M&As on stock priceperformance by focusing on abnormal returns). A major drawback of this approachlays in the fact that stock price movements rely on the anticipation of investorsas to the benefits and costs of M&As rather than on actual value creation (VanderVennet, 1996; Capron, 1999; Cybo-Ottone and Murgia, 2000; Beitel and Schiereck,2001; Lepetit, Patry and Rous, 2004).Conversely, studies of corporateperformance are less common because of the difficulty in collecting data andconstructing valid proxies for performance. An additional problem lies in thedifficulty of controlling other determinants when singling out the effect ofM&As on firm performance.
Despite these limitations, the issues consideredby these approaches are pre-merger profitability, post-merger performance, andwho benefits most (the acquirer or the target company?) (Seth 1990).Pre-merger profitability streamof research focuses on the study of ex ante corporate performance in order toidentify potential acquirers and targets. Mueller (1980) in his summary of theresults on company performance studies concludes that there is a negativecorrelation between performance and the probability of being taken over,although the difference in performance is small and often non significant.The acquirer is typically large,and has higher growth and higher debt levels. Therefore, the weaker theperformance of a company, the more likely it is to become a target. Stock pricestudies reach the same conclusions. This might suggest that the market forcorporate control is functioning properly with more efficient companies takingover less efficient ones.
The empirical studies looking at post-mergerprofitability have mainly used data on stock market returns to assessacquisition performance. In doing so, they focus on market expectations offuture cash flow growth in order to capture anticipated outcomes. Nonetheless,these empirical investigations (belonging to the finance literature) have oftenproduced quite diverse results on the conglomerate post-merger performance. Themain problem is due to the type of data employed (stock market values) asincreases in shareholder value after consolidation may be too limited to confirmefficiency gains. Other empirical studies investigate post-merger performanceby examining profit data by line of business (Ravenscraft and Scherer, 1987).
However, typically no improvement is detected on average after acquisition.Finally, the phenomenon has beenfurther explored by using accounting data, but no convergent results have beenattained. The lack of convergence in the results has been attributed to a lackof consistency in methodology, time frame, merger type, country, and samplesize used. In this respect, a step forward has been taken by Mueller (1980) whoexamines acquisition performance in seven countries during the same period andusing the same indicators.
Nonetheless, Mueller’s effort has not established aconsistent pattern either. No consistent improvement or deterioration in theprofitability of merging firms in the first three to five years following amerger could be detected.Empirical research has alsoattempted to disentangle the performance of acquirer and target companies inorder to partition the gains from M.
This issue has been mainly analyzedin the corporate finance literature, using event studies. The evidence gatheredfrom this literature consistently favors acquired firms as the gains of theacquirer are often found to be non-significant (Agrawal et al. 1992; Hayward andHambrick, 1997). This implies that acquiring firms often pay large amounts for targetfirms gaining little or nothing from the announcement of an acquisition. Twomain issues arise in this context.
First of all, it has been investigatedwhether the difference in behaviors between the average target and the averageacquirer shareholder allows bidding firms to sustain their bids. The resultsshow that there is agreat variation in the acquirers’performance following acquisitions, which suggests that this variation may bemore important than the average (mean) performance, and appeal to a morerisk-taking category of shareholders. Second, as part of the investigation of thepartitioning of benefits between a target and an acquirer, questions related toanti-takeover provisions have arisen. In this respect, it has been shown thatmanagement tactics to prevent takeovers reduce the probability of a takeover,but raise the acquisition price if the takeover goes through.
Therefore, if thesetactics favor shareholders of target firms, they damage shareholders of acquiringfirms.